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Why succession planning is not just for the wealthy

Friday, March 03, 2023

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Why succession planning is not just for the wealthy Financial Analyst
Why succession planning is not just for the wealthy

Succession | Intergenerational Wealth Transfer | Tax Planning | Financial Advice

Much like most of the public has yet to create a will, most entrepreneurs have no succession plan in place. This might be because they have no family or because they don’t know where to start. But, often, it comes from the perception that succession planning is reserved only for high-net-worth individuals.

The challenges of passing down a business

A 1980s study on manufacturing companies in the US showed that only a third of family businesses make it through the entire second generation, whilst only 13% survive the third. This is particularly concerning when 90% of businesses in the US are family owned (either passed down or concurrently run by relatives). This number is less in the UK, but it’s still the majority in most countries around the world.

A big threat to a business’s longevity is when the owner is not thinking in terms of decades, but rather year-on-year performance. The uncertainty of having no clear plan in place can lead to disruption among employees, a reduced valuation, legal issues, and family conflict.

But, things get even more tricky when looking at the modern-day entrepreneur. Entrepreneurs are deviating from traditional family business structures, bringing even more challenges. For example, consider the remote running of a letterbox media agency from abroad. Does anybody take over? How is this asset passed on to overseas families? This makes succession planning a little more elusive in a time when estate planning has never been so important.

Why succession planning is for everyone

When a business gets to a certain size, there are forces in place that can ensure its own survival. Stakeholder expectations, shareholder meetings, and the separation of ownership and control can offer some self-correcting guidance to high-net-worth individuals - be it as a founder or shareholder.

But, smaller business owners are very much on their own. With more control boiled down to fewer individuals, succession planning becomes all the more important. And, when the second generation doesn’t get a chance to take over in 70% of cases, this is clearly an area of neglect.

Of course, succession planning doesn’t have to be about passing a business on to relatives. When committing to proper succession planning, it may be apparent that no relative is appropriate or shares the same vision.

Estate planning is about consolidating your assets and identifying the beneficiaries. And, succession planning shouldn’t be viewed any differently.

Risks of poor succession planning

It’s evident that the chances of a business’s survival are reduced with poor succession planning. Here are some possible reasons why.

  • Losing talent and CEO replacement
    Employees with institutional knowledge and experience are valuable assets. Losing key employees who possess critical knowledge can result in losing important relationships with stakeholders, and also can lead to lost business.  There could be significant costs associated with finding a replacement, in the form of increased remuneration and benefits, agency costs to find suitable replacements, and potential lost revenue during the period until a replacement starts to become effective in the role.

    A solid succession plan can help prevent these issues by creating opportunities for internal talent to progress and take on key leadership roles. Furthermore, hiring external CEOs is often named as a big cause of poor succession planning. Studies show that there is a temptation to opt for someone with CEO experience, but this neglects insiders with better knowledge. Developing is key, not simply replacing.
  • Financial cost
    It’s clear that among larger companies, unplanned CEO turnover results in a 14% decline in total shareholder return over a two-year period. Additionally, poor succession planning reportedly wiped out around $1 trillion from the S&P 1500. The same is true for smaller businesses, only the outlook for survival is even worse. An increase in staff turnover and a decrease in productivity can be costly to smaller firms. Even if internal talent is correctly identified, passing on the ownership to a dependent can immediately decrease the value of the business - and thus your estate - if not done correctly.​​​​​
  • Vision and culture
    Because SMEs are often built on one person’s vision, it’s integral that the future leader shares this vision. So, making a last-minute decision to pass the business on to a child or outsider could bring many problems if it’s abrupt. Entrepreneurs should preserve a company’s culture and vision. A stark change via a new leader’s vision can demotivate employees, derail company culture, and become a threat to the company’s mission.​​​​​
  • Estate planning
    Usually, a business is a means of wealth building. And, wealth building is usually a means of estate planning. The goal is to give our dependents a better life than we had. Poor succession planning is a huge threat to estate planning. A messy organisational structure with no clear future is not a secure way to pass on wealth.
Getting started and the role of an adviser

The ultimate goal of succession planning is for the transition of passing on the business to be as smooth as possible.

No matter what stage of the business you are in, it’s never too late to begin. In fact, the longer the time frame of the plan, the smoother the transition will be. More importantly, this is a process that all business owners need to consider, not just owners of large firms and estates.

One of the biggest reasons for having no plan is that the owner doesn’t know where to start. This highlights the importance of speaking to an adviser early on and the legal complexities they can navigate through.

A succession planning adviser can objectively assess the business and its leadership. There are immediate benefits to yield here too, such as finding gaps in leadership and areas of improvement.

From here, you will work with an adviser to identify potential successors. This means assessing the skills, experience, potential, and vision of potential candidates. Then, a transitionary plan is made with legal and financial considerations and developing personnel accordingly. Compliance, taxation, and efficient estate planning are where an adviser shows their worth.

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